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Investing in the stock market: why you can and should ditch your money manager today

Updated on April 8, 2015

Why you should invest in the stock market

Once upon a time, there was a concept called "interest" that applied to checking and savings accounts held at banks. This meant that your money made money, just sitting there. Ask your grandparents about it, I'm sure they'll remember it fondly.

Nowadays, holding your assets in a bank actually costs you money via monthly and random discretionary fees, which is not great if you like to be alive and buy things.

Furthermore, there is this thing called inflation that effectively makes your money worth less the longer you let it sit there. The idea here is that over time things cost more money, so your money is worth less; at a rate of about 4% per year.

This all sounds bad, but there is absolutely something you can do about it. Enter the stock market. Historically, securities on average have enjoyed a return of around 10% in the 20th century. This means a wealth increase of 6%, adjusting for inflation.

I don't remember who said more money more problems, but that individual is mistaken. Investing in the stock market is one step you can take to combat this blatant ignorance.

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What do stock brokers actually do?

Most of their job is convincing you that they know what they are doing. Money managers get paid when you invest and make transactions, so they have less incentive to actually make good decisions, and are more likely to push fancy, newfangled products into your face. This is where we get in trouble with CDO's and other ill-founded concepts that led to the global financial collapse in 2008.

The other part of their job is redefining what your actual return is and glazing over the fact they are skimming profits left and right by way of transaction fees, management fees, performance fees, and the seldom understood but highly costly 12b-1 fees.

There are some managers that actively try to make their clients money by over-analyzing accounts and frantically re-balancing holdings, but these efforts all too frequently result in exacerbated, and hidden costs that will be discussed further.

Can stock brokers earn you a higher return?

The simple truth is that there is no evidence to suggest that money managers can consistently beat the market. So much research has been done on the subject I am shocked that the internet isn't full yet.

You might be saying: now wait just a second young lad, my manager claims to have beaten the S&P 500 for ten years consecutively, and I trust him. Well, there is a perfectly reasonable explanation, even if his claims are not fictitious, and the answer lies predictably in statistics.

Just like pretty much everything, the performance of different stock brokers follows a normal distribution. Some get lucky, and some fall short, but most fall in the middle. The interesting thing, albeit admittedly obvious, is that the mean of managers' returns falls on the mean of the market in aggregate.

While there are some managers that beat the market seemingly consistently, this is expected according to fundamental statistics. This does not mean that they will beat the market in the future, just like flipping heads 10 times in a row does not affect the odds on the 11th toss. Luck is not an inherent characteristic of any entity, it is a social construct used to justify humanity's ignorance of statistics.

In short, if you believe basic mathematics, you shouldn't believe your money manager. You could literally throw darts at a newspaper to pick stocks and outperform most managers after fees are taken into consideration. I know this because we did that experiment in FIN 651 with professor Stefano Gubellini.

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How much are they charging for this?

We have talked a little bit about the different types of fees, enough to know that there are a lot of them, and to hint at the fact that they add up quickly. I believe a detailed discussion about their exact methods of skimming off of the top is better left to an entirely separate article. For now, let it suffice to say that they are profoundly varying and convoluted in practice.

What you need to know is how this affects your bottom line. Current research suggests that an accurate reduction in profits is around 40%. That means that for every dollar the market returns, you are giving away 40 cents and keeping 60. Knowing that managers struggle to beat the market will hopefully aid in setting this phenomenon in perspective.

The good news is, you totally don't have to submit to this unjust treatment.

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How can I get around money managers' fees?

If you really trust your adviser's intuition, despite everything I have told you so far, there is a relatively simple way to copy, or shadow, their portfolio. For legal reasons, financial institutions are required to publish what is called a Form 10-K, which is publicly available in the EDGAR database found at the link below or by searching "edgar" in Google.

Once you find the firm's prospectus, simply look up what securities they are holding and in what relative percentages. You may be lagging a bit in the sense that the 8-K and 10-K documents are filed only quarterly and annually, but in all likelihood you will far surpass their performance when fees are taken out of the equation.

Did you click on that link to check out some 10-Ks?

See results

Is a diversified portfolio really that important?

That depends on your priorities as an investor. More accurately, it depends on your relationship with risk. Most people are described as being risk-averse, meaning that they value a safe gamble with a lower return more than a risky venture with more at stake. A semi-accurate rule of thumb: if you do not have a chronic gambling problem, you are probably risk-averse.

A popular system among novice investors is to pick a few companies that they like and invest way too much of their portfolio in them. The problem with this is the stocks they pick likely have too much co-variance, i.e. too much in common. Simply put, if one stock under-performs, the rest of your portfolio probably will too. This is bad for risk, and in turn the risk-averse investor. Diversifying your portfolio is the solution.

An analogous situation would be as follows: you could randomly throw darts (single stocks), or just take the whole dartboard (diversification). Throwing all bullseyes would grant a higher return, but you also run the risk of missing the board entirely.

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What are the best stocks to invest in?

Assuming risk-aversion, the typical investor should strive to maximize an equation known as the Sharpe Ratio. Simply put, you want the highest return for the lowest risk. This sounds straightforward, but the unpredictability of the market can make choosing securities with consistently high ratios a nightmare in practice. Again, diversification is your friend here.

What people normally associate with diversification is holding a lot of different stocks. This is good practice, because the law of large numbers is on your side, but the real problem is co-variance. If you have 20 stocks that all follow each other, it is not much different than just holding one stock.

What good diversification means is minimizing co-variance. You can do this by strategically holding stocks that differ in return profiles, but the easier route is to hold thousands of stocks that vary across industries, capitalization, and other key metrics.

Fortunately there are classes of securities that do this for you. Chief among them are index funds and exchange traded funds (ETFs). What these positions do is attempt to mirror an entire asset class such as the S&P 500. The great thing is that they get roughly the same rate of return as the market for a fraction of the cost of money managers.


What are ETFs?

I'm ready, where do I start?

There are plenty of resources for investing online. You can check out TD Ameritrade, Scottrade, TradeKing, eTrade, OptionsHouse, and TradeMonster just to name a few. The super important thing here is to wait and take advantage of the promotions that these companies offer constantly. Read the fee structure intensively for any red flags.

If you visit all of these sites right now, there is probably at least a few of them that have an active promotion that gives you 100 free trades and no monthly fees. This will save you a bunch of money in transaction and management fees, which will help your bottom line.

You can also usually find a list of commission-free ETFs on many online brokers' websites. Utilize these lists when selecting your assets to minimize fees and further bolster your returns.

Please note that investing is by its very nature risky, before you go all gangbusters, please read the advisory notices that follow.

Investor Mistakes: attempting to time the market

You might have noticed that the stock market seems to be very chaotic. This is a very astute observation, and has distinct implications for how you should manage your portfolio. The price of securities follow what finance gurus call a "random walk." This phenomenon is highly persistent in nature and can befuddle what would otherwise be a savvy investor.

A random walk is exactly what it sounds like. The immediate future of a stock's value is inherently unknown. Anyone claiming to have knowledge otherwise are either lying to you, or have access to highly illegal insider information. The latter of which would not be shared with you, since there is no reason for them to disclose such a lucrative tip, so my bet is that he/she is blowing wind up your skirt.

The two main tenants of this misconception are as follows:

1) This stock's price keeps going up, its probably going to keep going up, buy now!

2) This stock's price just plummeted, it's probably going to recover soon, buy now!

Obviously, these two arguments are mutually exclusive. Since neither have been either consistently proved or disproved, the logical conclusion is to reject both premises. In short, do not allow yourself to be deluded into thinking you can time the market.

Investor Mistake: trading frequently.

At this point, you have realized the prohibitively high cost structure of traditional managers, and have opted to do it on your own. Congratulations, but don't get too hasty just yet. The whole point of investing on your own is to circumvent transaction and management fees. This effort will be altogether thwarted if you get all excited and start flipping stocks left and right. There are numerous costs associated with stock transactions, and none of which add any real value to your investment.

The hyper vigilance of an overly active investor can quickly cut into his/her profits. This is a practice known as "day trading", and is better left to those with inside information and sophisticated computer algorithms. These entities are much more adept at sniffing out market fluctuations and pricing arbitrage. If you don't recognize the term arbitrage, you're probably better off picking some well diversified ETFs and letting them distill in peace.

Furthermore, if you're the type of person that wants to give their money to a stockbroker and just let them work their "magic," then day trading probably isn't for you (not that I would suggest it in the first place).

Investor Mistake: believing the hype

This happens way too frequently, a company like Apple issues an IPO, and everyone just loses it. Don't fall prey to this phenomenon. What happens is a lot of people get all excited and drive the price superficially high, then once the excitement subsides it takes your money with it.

Some people might want to take advantage of this and short the option, which is totally a potentially lucrative move if you are able to play off the market arbitrage, but I would warn you to remember the unpredictable volatility of the market. If anything, do the opposite of what is popular, but keep in mind the nature of the random walk.

Summary

To summarize this rather lengthy dissertation, here are a few key points. First, you should definitely be investing in the stock market if you want to trade a small amount of risk for a higher (or even positive) return on your money. Next, do not trust a money manager. They will cost you way too much money. Lastly, using this guide, you have every ability to start investing on your own successfully. You will probably even beat your old stock broker.

Good luck!

© 2015 Luke M. Simmons

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    • Luke M Simmons profile image
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      Luke M. Simmons 3 years ago from Encinitas, California

      @Jacob: Yes, there will probably always be a place for money managers to help people that are just unwilling to do the leg work. This probably encapsulates the majority of the population. It is hard for people to distinguish the wolves from people like you, but I do commend the ethical advisers. Thanks for your input.

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      Jacob D 3 years ago

      I agree with your point that money managers are not for everybody in this new era of easily available information; however, money managers do still serve a purpose in today's society for the people unwilling, or unable to do the necessary research to establish a well diversified portfolio. Which consists of more than just diverse stocks, but many of other types of securities that are not accessible without a registered representative. I know that you are an intelligent human, and have done a lot of research and are very educated in the field of finance, but the fact of the matter is that not everyone is capable of researching, executing, and maintaining their own finances.

      By no means am I attempting to say that it is impossible to successfully manage your own portfolio, I manage my own portfolio and have outperformed the market, and also my demographic constantly. But this is no easy task, and I do not think it would be possible without a lot of hours going towards research that not all people are willing to do.

      Overall, I agree with your point that a money manager might not be right for everyone, but also not every Financial Advisor is the Wolf of Wall Street. Representing somebody on the other side of the situation, I know how much work does go into the position.

      Great read, informative and entertaining. Keep it coming

    • Luke M Simmons profile image
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      Luke M. Simmons 3 years ago from Encinitas, California

      @Glenn: thank you for the endorsement. Coming from a 35+ year vet, that means I must have got something right, haha. Thanks for reading and taking the time to comment. Cheers.

    • Glenn Stok profile image

      Glenn Stok 3 years ago from Long Island, NY

      I have over 35 years experience trading in the stock market. I can attest to your statement about trusting managers. Twice in my life I had account managers lose tremendous amounts of my money. I've come to the same conclusion as you. They know no more than the rest of us.

      The fact is that the market is not predictable. I agree with you. The best thing to do long term, for those who want to invest, is to be diversified with an investment in an ETF. And then just leave it there.

    • Luke M Simmons profile image
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      Luke M. Simmons 3 years ago from Encinitas, California

      Thanks @audrey, I'm glad you enjoyed it.

    • AudreyHowitt profile image

      Audrey Howitt 3 years ago from California

      So useful! Thank you!

    • Luke M Simmons profile image
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      Luke M. Simmons 3 years ago from Encinitas, California

      @aesta1: glad to hear it. All it takes is a little time and education. Let me know if you have any questions about different investing theories, I'm looking for new topics for finance hubs. Cheers.

    • aesta1 profile image

      Mary Norton 3 years ago from Ontario, Canada

      We have been investing for over 20 years now and in the first few years, I managed it until my husband got interested and now spends more time in it. We have learned most of our lessons so are now more confident in our choices.

    • Luke M Simmons profile image
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      Luke M. Simmons 3 years ago from Encinitas, California

      Thanks @linfcor. Just based on our short dialogue, I would say you possess the mental faculties required to learn. I definitely understand sticking to what works. There's some truth to the old adage: if it's not broken, don't fix it. However, it is my opinion that (specifically) your potential ability is not hindered by your intelligence. Either way, thanks for reading.

    • linfcor profile image

      Linda F Correa 3 years ago from Spring Hill Florida

      I think the article was very well written. Guess would be a little insecure trying to manage all my accounts by myself. Never saw myself as an e trader. Don't think I know enough to make a real success of it. But I learned a lot from reading this. Thanks

    • Luke M Simmons profile image
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      Luke M. Simmons 3 years ago from Encinitas, California

      @linfcor: thanks for taking the time to read the article. As you'll note, the market in aggregate has returned 10% in the 20th century. This performance can be matched by anyone using an index ETF, as I explain in the article. Given that only the accounts that you've chosen to highlight are returning 10%, I'm not exactly sure what justifies the planner's fees. Anyone can shadow the market. It literally takes less time than purchasing insurance from an animated gecko. If you have a good relationship with your manager, and are comfortable with the money that transfers from your account to his, then I have no business telling you what to do. This is not my goal. My only goal here is to be informative and to build confidence in the self-perceived abilities of the average investor.

    • linfcor profile image

      Linda F Correa 3 years ago from Spring Hill Florida

      I have invested for the long term over the course of the years. I have done very well with my managed accounts and have made over 8% and some accounts have even made 10% even in the worst of times. I am happy to pay my certified financial planner. We have strategized my accounts for my future and I could not have done it myself. Just my opinion

    • Luke M Simmons profile image
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      Luke M. Simmons 3 years ago from Encinitas, California

      @Hannah I'm glad to be of service. This is exactly why this article was written. Thanks for taking the time to read it.

    • Hannah David Cini profile image

      Hannah David Cini 3 years ago from Nottingham

      A brilliant article, one of my new years resolutions was to learn a little about the stock market so we could start investing and I have found this immensely helpful. Thanks for writing and sharing.

    • Luke M Simmons profile image
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      Luke M. Simmons 3 years ago from Encinitas, California

      @ Sharp Points: Haha, thanks for that. I wish you the best of luck in the market and on the mountain. Enjoy that fresh pow you guys have been getting. I hope to get up to our cabin soon.

      @ Becca Linn: Very good point, there are indeed restrictions with asset types available to certain brokers. Typically, this is due to the risky nature of these assets. Being that risk is positively correlated with return, gains in the 20's are absolutely within grasp. For most investors, who are risk averse, I would advise thoroughly evaluating the Sharpe Ratio of such assets. For the speculative trader, these types of securities are can be well worth the risk. I believe there will always be a place for these individuals, and I wish you the best of luck! As long as you are upfront with your clients, the market would be a much more accessible place with more brokers like you. Cheers.

      @ Matt: A most sincere thank you. I will keep them coming.

    • Matt Easterbrook5 profile image

      Matthew A Easterbrook 3 years ago from Oregon

      Keep up the great work on your hubs.

    • Becca Linn profile image

      Rebecca Young 3 years ago from Renton, WA

      This was a very interesting article. I myself have had some negative experiences with financial advisors in the past. I thought I was getting a great deal, but later figured out the fees were high, and my money was essentially trapped due to steep surrender fees.

      After that, you'd think I'd be completely against financial advising, but I've learned that not all financial advisors are created equally. It turns out that many financial advisors are fairly limited in the investment vehicles they can offer, because of the licenses they have... Or lack, and many of these are the ones like those I had dealt with in the past that held my money hostage.

      After my mother-in-law made 20% on her investments two years in a row, I was curious about what she was doing (that was much better than my investments were doing), and I ended up talking to her financial advisor who has an additional license that most others don't have.

      It qualifies him to work with investment vehicles that others without that license don't have access to.

      These have relatively low fees (about 1.5%) and no surrender charge. That means that investors can take their money back with no additional fee at any time if they aren't pleased with the returns his money managers are getting for them. That's pretty good motivation for him to stay on top of his clients' accounts and make sure they're doing well.

      He's making a little over 1% of what they are, and he knows they have freedom to leave at anytime. He can't just sit back and relax like someone would that just sold you an annuity with a 15 year surrender period.

      Since meeting with him and learning about the series 65 license he has that enables him to do that, I've gotten started with financial advising myself, so obviously I'm not totally against financial advisors... Just the ones that are ripping people off as you described. I'm very against doing that.

      Anyway, I think that for many people that don't have the time to really delve into educating themselves about this type of thing, it's good to have a financial advisor, but you want to make sure your advisor has the right credentials. A series 65 license is key.

    • Sharp Points profile image

      Sharp Points 3 years ago from Big Bear Lake, California

      Very useful and interesting. I have always been curious about how I'd fare in the stock market but haven't had the funds. This was a great read though, I am going to try it out. By the way, it was Biggie Smalls who said 'Mo Money Mo Problems.' Good writing!

    • Matt Easterbrook5 profile image

      Matthew A Easterbrook 3 years ago from Oregon

      Yes the stock market has been very generous to me through the years as an e-trader for myself. I agree do not do what you can do yourself. What you stated about 10-k and doing your own home work on companies and really checking out their assets and doing business analysis is vital to making the best possible trade. Great hub with great information that others can utilize. Enjoyed it a lot.

      Matt

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